China's revived economy rests on borrowed pillow

A man walks at Lujiazui financial district of Pudong in Shanghai, China July 17, 2017. REUTERS/Aly Song

HONG KONG (Reuters) - Gross domestic product grew 6.9 percent in the second quarter, beating expectations and capping a solid first half. Robust manufacturing, foreign demand, strong commodities and a softer dollar have lent the government time to attack bad debt and get housing prices under control. Naysayers have been silenced for now. But while confidence is warranted, complacency is not.

There’s no question that the world’s second largest economy is looking in its best condition in years. While official GDP data is not particularly enlightening, other more reliable indicators, including private surveys, also delivered pleasant surprises. Manufacturing rallied strongly, trade is vigorous, and producer prices - which deflated for years - have been reflating on the back of revived commodities prices. Retail sales rose 11 percent. All of this has, per the private China Beige Book survey, inspired businesses to expand hiring. This is indeed starting to look like the healthy “real economy” Beijing has been trying to stimulate for years.

How much of this is due to external factors is debateable, but they certainly helped. For example, Beijing beat back capital flight in 2017 thanks in no small part to the end of the global dollar rally. And net trade, usually a negative contributor to growth, has been robust enough that it accounted for 3.9 percent of GDP growth in the first half.

There are always worrying signs in any positive economic phenomenon. In this case it is the fact that credit tightening has yet to hit the wider economy - for all the deleveraging talk, credit creation has remained strong - nor have house prices corrected. What if the dollar resumes rallying? Strong export performance would make deleveraging easier, but that is dependent on external demand. Businesses may be overconfident. The Beige Book survey also shows that inventories are at record highs, and cash flows are still in the red for many firms.

Some believe that Chinese investors are betting on a “Congress Put,” the assumption that the government will keep up asset prices in the run-up to a political leadership reshuffle later in the year. If true, that means Beijing might have quarter of confidence to go. But not to waste.

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